Candlestick Chart Patterns

The Japanese have been using candlestick charts since the 17th century to analyze
rice prices. Candlestick patterns were introduced into modern technical analysis by
Steve Nison in his book Japanese Candlestick Charting Techniques.

Candlesticks contain the same data as a normal bar chart but highlight the
relationship between opening and closing prices. The narrow stick represents
the range of prices traded during the period (high to low) while the broad
mid-section represents the opening and closing prices for the period.

If the close is higher than the open - the candlestick mid-section is
hollow or shaded blue/green.

If the open is higher than the close - the candlestick mid-section is
filled in or shaded red.

The advantage of candlestick charts is the ability to highlight trend
weakness and reversal signals that may not be apparent on a normal bar chart.

The doji candlestick occurs when the open and closing price are equal.

An open and close in the middle of the candlestick signal
indecision. Long-legged dojis, when they occur after small candlesticks,
indicate a surge in volatility and warn of a potential trend change.
4 Price dojis, where the high and low are equal, are normally only seen
on thinly traded stocks.

The hammer is not as strong as the
dragonfly candlestick, but also signals
reversal after a down-trend: control
has shifted from sellers to buyers. The shadow
of the candlestick should be at least twice the height of the body.

A gravestone is identified by open and close near the bottom of the trading
range. The candlestick is the converse of a hammer and signals reversal when it
occurs after an up-trend.

We now look at clusters of candlesticks. How one candlestick relates to another will often indicate whether a trend is likely to continue or reverse, or it can signal indecision, when the market has no clear direction.

Engulfing patterns are the simplest reversal signals, where the body of the second
candlestick 'engulfs' the first. They often follow or complete
doji, hammer
or gravestone patterns and signal reversal
in the short-term trend.

Harami formations, on the other hand, signal indecision. Harami candlesticks indicate loss of momentum and potential reversal after a strong trend. Harami means 'pregnant' which is quite descriptive.
The second candlestick must be contained within the body of the first, though
the shadows may protrude slightly.

More controversial is the Hanging Man formation. A Hammer candlestick is a bullish signal in a down-trend but is called a Hanging Man when it occurs in an up-trend and is traditionally considered a bearish (reversal) signal. Thomas Bulkowski (Encyclopedia of Chart Patterns) tested the pattern extensively and concludes on his website that the Hanging Man pattern resolves in bullish continuation (of the prevailing trend) 59% of the time. It is therefore advisable to treat the Hanging Man as a consolidation pattern, signaling indecision, and only take moves from subsequent breakouts, below the recent low or high.

The Morning Star pattern signals a bullish reversal after a down-trend.
The first candlestick has a long black body. The second candlestick gaps
down from the first (the bodies display a gap, but the shadows may still
overlap) and is more bullish if hollow. The next candlestick has a long white
body which closes in the top half of the body of the first candlestick.

A Doji Star is weaker than the
Morning or Evening Star: the
doji represents indecision. The doji star
requires confirmation from the next candlestick closing in the bottom half of
the body of the first candlestick.

With a Shooting Star, the body on the second candlestick must be near
the low — at the bottom end of the trading range — and the upper
shadow must be taller. This is also a
weaker reversal signal than the Morning
or Evening Star.
The pattern requires confirmation from the next candlestick closing below
half-way on the body of the first.

While candlesticks may offer useful pointers as to short-term direction,
trading on the strength of candlestick signals alone is not advisable.
Jack Schwager in Technical Analysis conducted fairly extensive tests
with candlesticks over a number of markets with disappointing results.

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Library of Japanese Candlestick Reversal Patterns, displayed from strongest to weakest, in two columns: Bullish & Bearish Patterns. Reversals are candlestick patterns that tend to resolve in the opposite direction to the prevailing trend.

Library of Japanese Candlestick Continuation Patterns, displayed from strongest to weakest, in two columns: Bullish & Bearish Patterns. Continuation Patterns are candlestick patterns that tend to resolve in the same direction as the prevailing trend.